By Monica Rule

There is much confusion amongst some Self Managed Superannuation Fund (SMSF) members and professionals as to whether a child of a deceased SMSF member can receive a death benefit pension from their SMSF.  The confusion is caused by the requirements of the superannuation law for death benefit payments, the tax treatment of death benefits under the income tax law and the definition of a “dependant” under both laws.   

Compulsory payment of death benefits

Under the Superannuation Law, once an SMSF member dies their superannuation must be paid out of their SMSF as soon as practicable.  Death triggers a compulsory payment situation and, therefore, the deceased’s superannuation cannot remain in their SMSF and also cannot be added to their beneficiary’s accumulation account. 

Who can receive death benefits?

The superannuation law allows for payment of death benefits to either the deceased’s dependants or their legal personal representative. A death benefit cannot be paid directly to a non-dependant from an SMSF. If a non-dependant is to receive the deceased’s superannuation entitlements, then they can receive the payment via the deceased’s legal personal representative.   This means, an SMSF member can nominate a dependant to receive their superannuation entitlements upon their death, or can nominate a legal personal representative to have their superannuation distributed in accordance with their Will to dependants and/or non-dependants.

Dependant under the Superannuation Law

A “dependant” of the deceased member, under the superannuation law, is a spouse, a child of any age, anyone who was in an interdependency relationship with the deceased member prior to their death, or anyone who was financially dependent on the deceased member prior to their death. This means any child of the deceased, regardless of their age, can receive a death benefit directly from their deceased parent’s SMSF.

Form of death benefits

Under the superannuation law, a death benefit can be paid in one lump sum or paid over two instalments (i.e. an interim lump sum and a final lump sum). This form is referred to as a “lump sum death benefit”.  You cannot make a lump sum death benefit in more than two instalments.  A death benefit may also be paid as an income stream which is referred to as a “death benefit pension”.  The deceased’s dependants and non-dependants can receive lump sum death benefits.  However, only certain dependants can receive death benefit pensions.  When it comes to the deceased’s children, only children under the age of eighteen; or, up to age twenty four and financially dependent on the deceased prior to their death; or, children of any age with a disability of the kind described in subsection 8(1) of the Disability Services Act 1986, can receive a death benefit pension.  The age of the child and the financial dependency status is tested on the date of death.  It does not matter if the child is no longer 18 or that their financial dependency has ceased on the date of payment.  Also, once the child reaches the age of twenty five, the balance of their death benefit pension must be paid as a lump sum death benefit.  However, a child with a disability can continue to receive the death benefit pension beyond the age of twenty five.

Dependant under the Income Tax Law

Under the income tax law, the deceased member’s spouse or former spouse; the deceased member’s child under the age of 18; any person with whom the deceased member had an interdependency relationship with before they died; or any person who was a dependant of the deceased person just before their death is classified as a “death benefit dependant”.  This means, not all children of a deceased member are classified as a “death benefit dependent”.  An adult child who is eighteen or over and not financially dependent on the deceased prior to their death or, was not in an interdependency relationship with the deceased prior to their death is not a “death benefit dependant”.  An interdependency relationship is a close personal relationship between two people (whether related or not) who live together, where one or both provides financial and domestic support, and care of the other.  An interdependency relationship also exists if two people have a close personal relationship but do not live together due to either or both of them suffering from a physical, intellectual, or psychiatric disability.  

Tax payable on lump sum death benefits

Under the income tax law, if the recipient of a lump sum death benefit is classified as a “death benefit dependant”, then no tax is payable on the lump sum death benefit. Tax payable on a lump sum death benefit paid to a child who is not classified as “death benefit dependent” is at a maximum of 15% plus the Medicare Levy on the taxed element of the taxable component and a maximum of 30% plus the Medicare Levy on the untaxed element of the taxable component of the lump sum death benefit.  A lump sum death benefit will only include an untaxed element if the SMSF has claimed a tax deduction for a life insurance policy taken out on the deceased member.  If no tax deduction has been claimed, then the proceeds of the insurance policy will be treated as a taxed element of the taxable component of the lump sum death benefit.

Tax payable on death benefit pensions

The tax payable on a death benefit pension is dependent on the age of the deceased member, the age of the death benefit pension recipient and the components of the pension.  If the deceased member or the pension recipient was aged 60 or over on the date of the member’s death, then no tax is payable on the death benefit pension on the tax free and the taxable components.  Tax will be payable on the untaxed component of the pension at the recipient’s marginal tax rate with a 10% tax offset.  If the deceased member and the pension recipient were both under the age of 60, then tax is payable on the taxable component of the pension at the recipient’s marginal tax rate plus the Medicare Levy.  A 15% tax offset is applied to the taxed element.  No tax offset is applied to the untaxed element of the pension payment.

Financial dependent

In order for a child to qualify as a death benefit dependant under the financial dependent grounds, the level of financial support must be significant. The child would need to be financially dependent on the deceased on a regular basis to sustain their standard of living.  In the Tax Office publication ATOID 2014/6, it gave an example of an adult son living with his parents and receiving the Youth Allowance payments from Centrelink. The son was classified as a death benefit dependant as his Youth Allowance payments were calculated at a lower “at home” rate as opposed to the higher “independent” rate. This indicates that the son was substantially financially dependent on his deceased parent.

The Tax Office position on financial dependency is based on whether if the financial support received by a person was withdrawn would the financially supported person be able to survive on a day-to-day basis.  If the financial support provided, merely supplements the person’s income and represents “quality of life” payments, then it would not be considered substantial support.  What needs to be determined is whether or not the person would be able to meet the person’s daily needs and basic necessities without the additional financial support.

Interdependency relationship

In the Tax Office publication ATOID 2014/22, it gave an example of an adult child who had given up work to care for his terminally ill parent and received no financial support from anyone other than the parent.   It was stated that the adult son satisfied the interdependency relationship requirement as well as the financial dependency requirement.

Recently, in the Administrative Appeals Tribunal case TBCL and Commissioner of Taxation [2016] AATA 264, a son born in 1991 (an only child) lived with his parents consistently until 2007 when he moved to Melbourne to undertake pilot training.  He returned to live with his parents in 2009 until his death in 2013.  The parents paid $40,000 towards the total cost of the deceased’s course, accommodation of $250 per week and living expenses of $1000 per month while he lived in Melbourne.  The parents also bought the son items such as a computer, TV, pilot gear and a motor vehicle.  In 2013, the son was working as a pilot and tragically died in a motor vehicle accident.  The parents and son shared their living expenses (such as $300 per week for food, $850 for electricity per quarter, council rates of $3000 per year and water charges of $1600 per year) equally.  The parents provided the son with domestic support in the form of preparing meals, doing laundry, cleaning, and a number of other tasks.  In turn the son helped his parents by performing tasks around the house. The parents and the son provided each other with love, care, affection and psychological assistance.

In November 2014, the ATO provided a private ruling to the parents that they were not death benefit dependants of the son.  The parents asked the AAT to review this decision. The AAT concluded that based on the above evidence provided, it was not enough to establish an interdependency relationship.

The AAT case indicates that where an adult child only has a regular relationship with their parents and only lives together for the reasons of commercial convenience, then an interdependency relationship will not exist.

For Gold and Platinum members, Monica has provided explanations and examples of death benefit pensions for children under the superannuation law changes effective from 1 July 2017.

Monica Rule is an author and an SMSF Specialist – www.monicarule.com.au

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

Related documents:

• Self Managed Superannuation Fund Deed
• SMSF - Update Rules
• Investment Strategy for Self Managed Super 17/18
• SMSF Limited Recourse Borrowing Arrangement

Related webinars:

• Webinar Recording - Time to Address the SMSF Sleeper - Estate Planning within the fund
• Webinar Recording - Understanding the 2017 Superannuation Changes
• Webinar Recording - When a Will is not Simple